When inflation reached the rate of 6.8 percent in year-over-year consumer prices as of November 2021, this signaled investors that prices would continue to rise. Investors were seeking ways to maintain asset values and continued growth in these rapidly changing economic conditions. One encouraging fact was that commercial real estate has been a significant hedge against inflation for the past 40 years.
During periods of high inflation, any money that you have in a low-interest bank account is steadily decreasing in value. This cash will purchase few products and services for you every month or quarter of the year. High inflation rates can also have a negative impact on the value of stocks and bonds.
In fact, leading economists have stated that an increase of one percent in the inflation rate can result in a reduction in bond prices of approximately 1.5 percent and a drop in stock prices of 4.2 percent. Yet, rising inflation rates can have a positive effect on physical assets like commercial real estate, and especially apartment buildings.
Multi-unit properties have inherent value since they are income-generating real estate. In some urban areas, these buildings and complexes may be limited in number. This provides the owners of these buildings with the incentive to raise apartment rents as inflation rises. It also encourages developers to construct more housing of this type.
In times of high inflation, more property developers have a strong interest in maintaining an ownership percentage in apartment properties that they have built. These developers understand the potential financial profits to be gained by investing in multifamily real estate. They also know the value of holding these commercial real estate (CRE) properties as long-term investments.
Also, rising inflation frequently occurs when there are periods of economic growth. During these times, landlords of apartment buildings can have high occupancy rates for their properties. More people are looking for apartment rentals, and they can pay the higher rents being charged due to high rates of inflation.
However, investing in multi-unit real estate is not without risk. Although apartment properties typically have full or high occupancy rates, tenants may fall behind in their rent payment during these times. Some apartment complexes have retail stores on the ground floor.
These commercial tenants may be forced to close their businesses due to high inflationary rents and plummeting merchandise sales. Subsequently, it may take time to find new retail tenants for these vacant store spaces who can afford the current rental rates. It is always wise to perform due diligence on the economy and rental patterns of any locale in which you have an interest in making property investments on developments.
Helpful Tips for Successful Investing in Apartments During Inflation
Tips from experienced CRE investors who profit from developing and investing in apartment properties include the following:
- Locate Assets with Cash Flow. Apartment developments with current tenant leases that can be adjusted in alignment with escalating inflation rates can be excellent investment properties. In addition, multi-unit buildings with shorter-term leases enable property owners to raise rents faster and more easily.
In multifamily real estate, leases may vary from monthly to annual rental agreements, unlike office buildings, which often have five to ten-year leases. Young working people and new tenants with families who are relocating will often accept short-term leases to secure a new home before or soon after they relocate.
- Look for Reliable Fixed Rates. As CRE properties, apartment buildings are typically financed with long-term loans. Sometimes an inflationary period occurs within a time period when fixed monthly interest fees are due. Any of these properties that have loans with variable rates are at greater risk of interest rate hikes during times of inflation.
CRE properties are often financed with fixed-rate, long-term loans of as much as 10 years. These building owners may borrow as much as 60 to 70 percent of the value of their property. This can also serve as a hedge against inflation. If a period of high inflation takes place while a loan term with fixed monthly interest fees is in effect, these building owners are not impacted by a rapid spike in interest rates.
Yet, any property that is financed with a floating-rate loan can be subject to higher interest rates when inflation rates rise. Also, it can be more difficult to gain approval for a mortgage when the rate of inflation is high.
Refinancing a current low fixed-rate mortgage can also be difficult. In addition, a fewer number of loans may be obtainable for commercial property owners during times of escalating inflation. Even if these loans are available, lenders may charge high interest rates.
By using triple-net leases, landlords can pass 100 percent of costs relative to their properties on to the tenants. For example, when maintenance or utility costs escalate due to inflation, these building owners are somewhat protected from losing additional cash flow since they are not responsible for covering these rising costs.
Landlords who rent space to commercial tenants who own shops or restaurants can pass even more of the ongoing building costs to these tenants. These costs charge to commercial tenants can include property insurance, real estate taxes, rent and utilities or maintenance expenses.
Commercial property assets, including apartment properties, can appreciate significantly of their investment lifespans. For this reason, long-term investors in these properties can gain impressive financial returns over time. In addition, these investment properties can act as a highly effective hedge against higher rates of inflation.
How Apartment Developers Use Properties to Hedge Against Inflation
Experienced property developers know that building and investing in large multi-family properties can actually make inflation work to their advantage. As a developer and investor, you can increase your profits as inflation rates rise higher. This type of property construction and investing is a tried-and-true inflation-hedging practice.
Many developers of apartment buildings and complexes are also connected with real estate syndications that invest in these properties. They know that they can count on certain syndicates and investment sponsors to supply the necessary passive investors and funding to ensure that these properties are return healthy profits as investments.
More Ways Apartment Developments Work Against Inflation
In general, rental revenues from multifamily properties keep an even pace with the rise of inflation. At times, these revenues may even surpass inflation rates. In the current U.S. economy, come urban areas have experienced rental rate rises of 30 percent during the last year. With a fixed-rate mortgage in place, loan payment remain stable. This builds a spread (fueled by rent income) between higher rents and mortgage payment expenses.
Insurance and tax costs also increase. Yet, income-generating real estate typically has more rental income than operating costs. In the majority of apartment properties, owners expenses are frequently equal the half or the rental income. When inflation rates escalate, greater income from higher rental fees easily offset the property operating costs.
When passive investors in syndicated real estate investments pool their funds to invest in attractive apartment property developments, they are adding valuable prperties to ther portfolios. They are investing in income-generating real estate that is much more stable than the majority of other investment assets today.
Developers know that many more consumers would choose to pool the amount of funds that they can currently afford with other passive investors to invest in large apartment property if they learn about real estate syndication. An experienced quality syndicate with an excellent track record for successful, profitable property investments can be of great benefit to both apartment property developers and real estate investors.
Developers Collaborate to Hedge Against Inflation
During increasing inflation rates in the economy, experienced multifamily property developers often collaborate or form partnerships to strengthen their protection against inflation. By combining their resources, experience and operating expertise, they can construct, own and operate highly successful apartment buildings as long-term investments.
These experienced developers can also divide responsibilities and financial commitments during and after the designing, building and finishing stages of these large properties. While some developers may be more experienced at overseeing the entire operations, others may be more knowledgeable and skilled at managing the hiring and general workflow of contractors, vendors and skilled laborers.
Just as in syndication property investing, joining knowledge, skills and financial resources to form a more secure and stable development team can help ensure a well-built, attractive and income-producing property that will benefit the community as well as the developers and their property investors.
Concluding Thoughts
Large apartment property developments are typically a strong, durable hedge against high inflation rates. As income-producing properties, these buildings and complexes benefit the property developer(s), owners and investors in these properties. At the same time, these developments are also of great benefit to the community since they provide more multi-unit housing for residents, which is very much needed today.
Especially in many urban areas today, there is a growing need for more apartment dwellings due to the increase in young families throughout the U.S. Many young working people and others also feel more comfortable about renting initially for their first homes and buying a home later on. They also know that is is easier to move more quickly from a rental apartment if their jobs should require relocating to another city or state.
For everyone involved and concerned, from developers and owners to investors and tenants, the development of more apartment properties provides varied benefits and advantages. In addition, apartment real estate developments are tried-and-true income-producing properties and powerful ongoing hedges against rising inflation.